August 16, 2011 1:16 pm

Russian market retreat highlights lingering risks

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Moscow equities

In a sea of sovereign debt crises and downgrade fears, Russia’s economic fundamentals should make Moscow markets look like a dream.

Government debt stands at just 9 per cent of gross domestic product, while Russian companies have significantly reduced their level of foreign debt over the past three years – one of Russia’s biggest problems in 2008. Meanwhile, the Moscow stock market has been one of the cheapest in the world with stocks trading at a price-to-earnings multiple of just six times.

Since Russian equities closely track the price of Brent crude, it would seem natural for Russian stocks to also feel the global volatility and experience an August correction of a similar size.

So why has RTS, Russia’s benchmark index, lost as much as a fifth of its value, if Brent futures have fallen less than 10 per cent?

This is the question Moscow investors are trying to answer as they evaluate whether improved fundamentals will push Russia above the fray this time round, or if hidden leverage, a retreat of foreign investors and little-changed market infrastructure will see Russia, once again, among the worst hit.

“The big fear with Russia is that it’s not different this time around,” says Roland Nash, chief investment strategist for Verno Capital, a Moscow-based hedge fund.

“I think that’s what everyone in the Russian financial markets is trying to deal with. Is this the best buying opportunity we’re going to see this year or is Russia going to repeat what it’s done so many times in the past, which is demonstrate that it’s a risky market.”

Cognisant of the ghosts of 2008 and the country’s 1998 default, the Russian government has acted quickly. The finance ministry has already injected Rb120bn ($4.2bn) into commercial bank deposits, and plans to inject an additional Rb80bn at next week’s deposit auction, while Vladimir Putin, the prime minister, has promised the government will continue to monitor liquidity.

Part of the reason why Russian shares have retreated so sharply is because Europe, Middle East and Africa-focused funds had taken long positions in the market, and needed to close them, says Charles Robertson, global chief economist at Renaissance Capital. Before the volatility, Russia had been one of the better-performing markets, and up 12 per cent on the year to date.

Yet the sell-off itself underlines one of the Russian market’s biggest problems, says Steven Dashevsky, a fund manager at Dashevsky & Partners in Moscow. “The biggest piece that has been missing and will be missing for a long time is a domestic investor base. That is what would make the markets more stable,” he says.

Other changes in Russia’s market infrastructure over the past three years have been more noticeable. While volatile trading triggered arbitrary market shutdowns for days in 2008, a new system allows blue-chip stocks to move as much as 20 per cent before an hour-long freeze on trading, and 30 per cent before a day-long freeze, reducing sharp swings in the market.

Steps have also been taken to make Moscow a more attractive financial market. RTS is in the process of merging with Micex, Moscow’s other exchange, which should facilitate the creation of a much-desired central securities depositary.

Investors also praise a decision by the market regulator to abolish restrictions on the number of shares Russian companies can sell abroad, a move they say will allow a company’s Moscow-traded shares to be priced equally to its global depositary receipts, instead of at a huge discount, and increase the liquidity of both stocks.

Risks, nonetheless, remain. Analysts, brokers and investors paint a vague picture of how leveraged the system is today and whether a steady stream of margin calls could wreak havoc. Eurofinance Capital, a minority shareholder in Micex, recently asked the central bank to block the two exchanges’ merger on claims it would lead to the deterioration of their financial standing. And a new law on insider trading has done little to stop suspicious movements in big name stocks, traders say.

While investors want to believe the Russian market is better prepared, they are still frightened of getting burnt, Mr Dashevsky says.

This time is different, he adds, “are the four most expensive words in the English language”.

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